About Jordan S. Terry

Founder & Managing Director, Stone Street Advisors LLC. Investment research and consulting for institutions, funds, family offices, wealthy individuals. Long/Short fundamental, value-oriented equity ideas as well as special situations (M&A, restructuring, strategic and leveraged recapitalization, pre-, in, and post bankruptcy). We like following corporate credit, particularly for special situations and short ideas.

P/E Ratios – You’re Doing it Wrong

This weekend I put together a short paper (it just worked better that way than as a blog post) wherein I explain how P/E ratios are routinely misused/abused by everyone from day traders to fundamental value investors and everyone in between. The issue is when you just look at the ratio, you simply can’t understand the fundamental factors that actually drive the ratio, and they are not, contrary to popular belief, just the price on your screen and last year’s or LTM earnings.

Here, I explain why it is imperitive for traders and investors alike to understand the drivers of relative valuation ratios like P/E – free cash flow to equity, equity cost of capital, and long-term growth rate – so that comparisons between firms, across industries, and over time have context, rendering comparison and analysis far more useful than just looking at current and historical levels or averages.

I use the model to determine the implied growth rate in the S&P 500 based on its P/E and question whether there may be a large disconnect between the rate that’s priced in (the implied number) and what analysts are projecting, which is significantly higher than the implied growth rate.

This short paper will help market participants of all stripes improve their though, research, and investment selection process, and only takes a few minutes, max, to read.

Enjoy!

P-E Ratios You’re Doing it Wrong 2015-4-19 v4

On the Perils of Management Access & Straying From Process: Our Adventure With Jones Soda

Summary

  • We initially were skeptical about Jones Soda (JSDA) due to declining and generally weak financials, questionable strategy, and uncertainty surrounding its turnaround plan.
  • After the annual meeting and a one-on-one with the CEO (& CFO), we became convinced the company was in capable hands, and the turnaround would go well.
  • Turnarounds are hard, particularly for severely resource-constrained firms. We now believe Jones should put itself up for sale rather than wait/hope for a small miracle.

  • Introduction

    In late May 2013, we started working for a client who was interested in knowing what we thought about Jones Soda (OTCQB:JSDA). It was a bit of a treat to be able to work on a company whose products I had enjoyed so much during my more formative years, and it provided me the opportunity to do a lot of work that I don’t often get asked to do, some banking and activism stuff in addition to research.

    Unfortunately, until very recently, I was bound by a non-disclosure agreement, which prevented me from sharing further analysis publicly. Now that I’m at liberty to write again, I want to discuss how we got the bullish call wrong in June 2013, what happened when we realized we were wrong, what we’ve learned in the process, and what we think about Jones Soda today.

    I’ve tried to be brief, but since there’s a lot of relevant background information, this isn’t exactly a quick read. If all you care about is our current view on the company, you may skip to the last section, though you’ll be doing so at the expense of understanding the bigger picture.

    A Good Analyst is a Skeptical Analyst
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    Stone Street Advisors LLC Seeks Equity Research Interns

    Stone Street Advisors LLC is seeking 2-3 undergraduate or graduate (MBA, MFin) interns interested in fundamental equity research (value-oriented, mostly bottom-up, long/short/special situations). This position is geared towards those interested in pursuing careers in investment research, investment banking, and asset management, to name a few.

    Ideal candidates will have coursework in accounting and finance as well as other business/law classes. Candidates do not need to have previous investment research experience, however we strongly prefer some practical experience as the classroom and the real world are vastly different.

      Extremely strong Excel proficiency is required; no exceptions.

    Native English speakers preferred; those without must demonstrate native written and conversational abilities. There are no university, GPA, or test score limitations/requirements for intern positions. All else equal, we don’t care where you went/go to school or what your GPA was/is; we want people who can do the job.
    Candidates must be extremely self-directed as the role involves a large degree of autonomy and self-teaching/learning. There will be a significant amount of education and instruction involved as well. Interns will work remotely with ~weekly in-person meetings and as-needed voice/video calls. Internships are part-time (approximately 20 hours/week +/-) and will start in February or March, continuing into early Summer. The position is unpaid.

    Responsibilities include but are not limited to:
    - Business, industry, competitive research and analysis
    - Financial statement analysis
    - Financial modeling and valuation
    - Developing and performing stock screens
    - Preparation of research reports and supporting material
    - Data collection
    - Marketing/sales
    - Ad-hoc assignments (no food/coffee trips, don’t worry)

    Cover letter is not required, though you should make an effort to introduce yourself and explain your interest in/qualifications for the position. A resume is required, transcripts are not. Be creative; don’t be afraid to use whatever material/approach you think appropriate to demonstrate your qualifications for the position. If your initial application suggests you may be a good fit, you will be given approximately a week to identify an investment opportunity that you think will return 50%+ over the next 1-3 years. You will submit an investment pitch, ideally showing your understanding of the business/industry, financial analysis, and valuation. We are looking to gauge your abilities, education, experience, knowledge, resourcefulness, thought process, and attention to detail, rather than the actual pitch/idea itself, though we are, naturally, looking for good ideas with solid analytical support as well. For an example of what we are looking for, see our Overstock.com presentation.

    If you want to learn, are teachable, and hungry, please apply here.

    Overstock.com: An Opportunity Begging For an Activist With 10x Upside Potential

    I’ve finally uploaded our presentation on Overstock.com (OSTK) to Slideshare, which now includes a summary of what we do here at Stone Street Advisors LLC, how we do it, and how we’ve performed since our founding in 2011. The investment thesis is fairly simple:

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    Unilife Releases OrbiMed Loan Covenants: Is Default Imminent?

    In May, we explained how UNIS – with the helping hand of the SEC – was able to file the OrbiMed credit agreement and leave out very important details, particularly what financial performance it had to achieve to avoid triggering an event of default/covenant breach:

    As far as we know, we are the only observers to find this unacceptable, as it allows UNIS to severely impair analysts’ and investors’ ability to evaluate the firm’s default risk and valuation.
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    Rulers For $0.25! Markers For $0.97! Honey, Get The Kids, Lets Go To Staples!

    I don’t cover Staples (NASDAQ:SPLS), nor do I claim any particular expertise in the office/school supply sector or other tangential businesses in which Staples attempts to operate. However, I can’t help but question the strategic thinking behind their current back-to-school commercials/promotions. Check out this extremely dorky “viral” video promotion to see what I mean.
    watch?v=RiNzhewb4ZI
    “Rulers for $0.25! Markers for $0.97! Honey, get the kids, we’ve got to get to Staples before we miss out on these amazing savings” …said no one.
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    Stone Street Advisors LLC Seeks Equity Research Interns

    Stone Street Advisors LLC is seeking 2-3 undergraduate (exceptions made for graduate students on a case-by-case basis) interns interested in fundamental equity research (value-oriented, mostly bottom-up). This position is geared towards those interested in pursuing careers in investment research, investment banking, and asset management, to name a few. Ideal candidates will have coursework in accounting and finance as well as other business/law classes. Candidates do not need to have previous investment research experience however it would be nice. There are no university, GPA, test score, etc. limitations for intern positions. Candidates must be extremely self-directed as the role involves a large degree of autonomy and self-teaching. There will be a significant amount of education and instruction involved as well. Interns will largely work remotely with ~weekly in-person meetings and as-needed voice/video calls. Internships are part-time (approximately 20 hours/week +/-) and start in July and extend through the end of summer, with the option to be extended into the Fall. The position is unpaid.

    Responsibilities include but are not limited to:
    - Financial statement analysis
    - Financial modeling and valuation
    - Developing and performing stock screens
    - Industry/company research
    - Preparation of research reports and supporting material
    - Data collection
    - Marketing/sales
    - Ad-hoc assignments (no food/coffee trips, don’t worry)

    Resume/cover letter not required although strongly encouraged. Be creative, don’t be afraid to use whatever material/approach you think appropriate to demonstrate your qualification for the position. If your initial application suggests you may be a good fit, you will be given approximately a week to identify an investment opportunity that you think will return 50%+ over the next 1-3 years and to provide analysis to support your conclusion. We are looking to gauge your base knowledge/experience, resourcefulness, and thought process rather than the particular outcome, although we are, naturally, looking for good ideas with solid analytical support as well.

    If you want to learn, are teachable, and hungry, please apply here.

    A Brief Example of The Limitations of Algorithmic Investment Selection

    Earlier today, I came across this interesting piece of “research” identifying Jos. A. Bank as a compelling long opportunity. For those out of the loop, JOSB is in the process of being acquired by Mens Wearhouse for $65/share. As you can see, since MW made its most recent offer (raising the price to $65, that is), JOSB hasn’t exactly been a great stock to trade, to put it gently. To wit:

    +3% and change since JOSB filed the press release announcing the higher takeout price, raised from $63.50 on 3/11 of this year, which was just the most recent bump in the long road that has been the MW-JOSB journey (which, if you’ll recall, started with JOSB offering to buy MW back in September of last year, a brilliant strategy in my humble opinion). The odds of the bid being raised from $65 at this point are, in my fairly well informed opinion, lower than the odds that MW’s board will change its mind after conducting due diligence (itself unlikely, but non-zero). Put simply, any trader/investor can do 5 minutes of work, 15 tops, to realize there’s little upside, and a lot of opportunity cost, not opportunity, getting long JOSB at this point.

    TheStreet’s QuantRatings system, available for the bargain price of “less than $1 per week!” touts, among other things, “In-depth analysis of the stock’s most important fundamental and technical factors…”
    One would hope that, among the many factors this or any system “analyzes” the existence of a tender offer (easily found in SEC filings, press releases, etc by man or machine) would be one of them. Alas…

    With novice and professional traders/”investors” alike increasingly relying on any “new information” in the market to inform their decisions (or, too often, confirm their preexisting views), such garbage systematic “research” is as much, if not more a source of risk than a source of opportunity.

    Making money investing/trading is not easy; assuming for even a moment otherwise is a surefire way to shoot oneself in the foot.

    As always,

    CAVEAT EMPTOR

    Stone Street Advisors LLC Equity Research Performance Analysis, 2011-Present

    When I started Stone Street Advisors, I hadn’t yet developed the full business plan, mission statement, or anything along those lines; I just wanted to do research and consulting differently, and had a general plan for so doing. Over the past few years I’ve refined my approach and my thinking to the point where today, I can be very clear about what the company does, why, and how we add value to clients.
    Simply put, our philosophy is that given finite resources and a finite amount of very high-return, high-conviction equity opportunities available at any given time, our effort is best spent identifying only the very best investment ideas, even if that means coming up with a few per year. We believe generating a handful of great ideas is far more valuable to our clients than several handfuls of ok-to-good ones. To be clear, we don’t presume to replace our clients’ existing research capabilities, but rather seek to complement them. We do not manage money, nor maintain a portfolio (actual or virtual), allowing us an unbiased perspective to focus solely on identifying long and short opportunities that we expect will return 50%+ over the next 12-24 months. While we do not explicitly make allocation or risk management (entry/exit/limits) suggestions, we try to convey all relevant risk factors to clients, especially for short and contrarian ideas.

    Since we’ve yet to have a client ask to see our track-record, I never kept anything more than a mental accounting of our stock picking performance, that is, until this week. Below are the results of the long & short ideas that we have published (the dozens of high-level analyses we’ve shared have been excluded) since 2011, both in absolute terms and relative to the S&P 500.

    Some highlights:

    - Long ideas returned, on average, 237% from initiation to their high price or 222.8% relative to the S&P500
    - Long ideas have returned, on average, 124.7% from initiation to their current price or 104.0% relative to the S&P500
    - Short ideas have returned, on average, 56.2% from initiation to their low price or 71.4% relative to the S&P500
    - Short ideas have returned, on average, 26.5% from initiation to their current price or 66.8% relative to the S&P500

    For inquiries, please contact us via information@stonestreetadvisors.com.

    Jordan S. Terry
    Founder & Managing Director
    Stone Street Advisors LLC

    Initial Thoughts on Unilife’s New Debt Financing

    Since I started looking at Unilife (UNIS), I’ve been extremely concerned with the company’s liquidity and solvency situation. They’ve been burning through cash like it’s going out of style and operating expenses are already very high and have kept growing at a fast pace. Operating losses every year meant the company already has significant negative debt service coverage ratios (i.e. they burn cash to pay debt service rather than using operating income to pay interest/principal). At the end of the last quarter (Dec 31), they were already highly levered with a Debt/(book) Equity ratio of ~0.74, placing UNIS in an elite group of companies — 0.74% of the 6,795 stocks in the Finviz.com database — with such high leverage and negative margins.
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